Why Are Oil Prices Falling? A UK Perspective

The global oil market has recently experienced a significant shake-up, with Brent crude oil prices dipping below $70 per barrel for the first time since 2021. This notable decline, seeing prices fall by over 7% year-to-date, has sparked considerable debate and concern across financial markets and among consumers alike. While such volatility might seem alarming, understanding the intricate web of factors at play – primarily the delicate balance of global supply and demand – is crucial to comprehending these shifts. This article delves into the underlying reasons for the current downturn in oil prices, exploring the complex interplay of economic deceleration, strategic production decisions, and evolving long-term forecasts that are shaping the future of 'black gold'.

Understanding the Recent Dip in Oil Prices

The recent trajectory of oil prices has been anything but smooth. After a period of relative stability, albeit at higher levels, the summer months witnessed a noticeable softening. This move below the $70 mark for Brent crude, though not sustained for long, signalled a significant shift in market sentiment. The question on everyone's mind is: why this sudden drop? The answer lies in a confluence of factors, predominantly a weakening demand outlook coupled with a robust and increasing global supply.

Analysts, including those from J.P. Morgan Research, have revised their projections for oil demand growth downwards. Their latest forecast anticipates an expansion of just 800 thousand barrels per day (kbd) in 2025, a reduction of 300 kbd from their previous estimates. This downward revision reflects growing concerns about the health of the global economy and its direct impact on energy consumption. When economic activity slows, so does the need for transportation fuels, industrial lubricants, and other petroleum-derived products, leading to a diminished appetite for crude oil.

The Crucial Role of Supply and Demand Dynamics

The oil market operates on fundamental economic principles: when supply outstrips demand, prices tend to fall, and vice versa. Currently, the market appears to be grappling with an imbalance where supply is either meeting or exceeding a softer demand. This dynamic is a primary driver behind the recent price depreciation. Let's break down both sides of this equation.

Decelerating Demand: The China Factor and Beyond

Perhaps the most significant factor contributing to the softening demand picture is the slowdown in China’s economic growth. For the better part of the last decade, China has been the undisputed powerhouse of global oil demand, accounting for a staggering 60% of all global demand growth. Its rapid industrialisation and expanding middle class fuelled an insatiable appetite for energy.

However, China’s economic landscape has shifted dramatically. Its GDP growth rate has decelerated sharply, falling from an annual rate of 7.5% in 2014 to 4.7% in the second quarter of 2024. This economic cool-down has had a direct and immediate impact on its oil consumption. The International Energy Agency (IEA) reported in September a significant deceleration in oil demand, with global growth for the first half of 2024 registering at a mere 800 kbd – the slowest pace since 2020. This contrasts sharply with the 2.3 million barrels per day (mbd) growth witnessed in 2023.

Specifically, oil consumption in China fell for the fourth consecutive month in July, decreasing by 280 kbd. This sustained decline from such a crucial consumer sends a powerful bearish signal to the market. While other regions like India, the Organisation for Economic Co-operation and Development (OECD) member countries, and the Middle East are experiencing some growth, it's currently insufficient to offset the significant slowdown emanating from China. Demand outside of China still remains 0.3% below 2019 levels, highlighting the pervasive nature of this demand softness.

Robust Supply: OPEC+ and Non-OPEC Contributions

Compounding the demand concerns is a resilient and, in some areas, expanding global oil supply. Despite the Organisation of the Petroleum Exporting Countries (OPEC) and its allies (OPEC+) having implemented production cuts in recent years to stabilise prices, the overall supply picture remains strong. In fact, OPEC itself boosted crude production by 411,000 barrels per day in June, reportedly to ensure members adhere to quotas. This apparent shift in OPEC’s reaction function, moving towards increasing supply, has been largely overlooked by the market but represents a significant bearish argument.

Looking ahead, several OPEC members are poised to further ramp up their production capacities over the coming years. The United Arab Emirates (UAE) is heavily investing in new capacity across its key oil fields, including Upper Zakum, Lower Zakum, Umm Shaif, Bab, and Bu Hasa. These investments are projected to translate into an incremental increase of approximately 200 kbd annually in both 2025 and 2026. Kazakhstan has also successfully deployed nearly 200 kbd of new production capacity at its Tengiz drilling base, adding to the global output. Meanwhile, Iraq is enhancing its refining capacity in Kirkuk and Basra, and Kuwait is modestly increasing its capacity in the Light Jurassic Formation. Furthermore, production in the Saudi-Kuwaiti Neutral Zone is trending about 40 kbd higher in 2025.

A crucial aspect of these expansions is the significant capital expenditure involved, much of which is being funded by major international oil companies. These firms are expected to channel more than $10 billion into the Middle East upstream sector each year from 2025 to 2027, underscoring a commitment to boosting future supply.

Beyond OPEC+, production growth outside of the cartel has also been robust. The U.S. Energy Information Administration (EIA) estimates that global production of petroleum and other liquid fuels will grow by 0.3 million barrels per day in 2024. This growth is largely driven by increased output from non-OPEC countries such as the United States, Brazil, and Canada, effectively offsetting any declines from within OPEC. The EIA further predicts that production will increase by a substantial 2.4 million barrels per day in 2025, suggesting that the risk of supply continuing to outpace demand remains very real.

Here’s a snapshot of recent and projected oil demand growth:

The Long-Term Horizon for Oil Demand

While current supply-demand imbalances are driving short-term price movements, the long-term outlook for oil demand is a significant concern for investors and producers alike. The global push towards green energy transition casts a long shadow over the future of fossil fuels.

The IEA, for instance, projects that oil demand for transportation use will begin to decline from 2026, with overall peak oil demand occurring soon after, around 2028. Their analysis suggests that oil demand in developed nations could fall to less than 43 million barrels per day by 2030, a considerable drop of some three million barrels per day since 2023. Financial markets, being notoriously forward-looking, are already pricing in the implications of a weaker China and a broader slowdown in global oil demand.

However, the industry is not monolithic in its predictions. Consultancy firm McKinsey, for example, maintains that traditional fossil fuels will remain an important component of the global energy mix until at least 2050. Similarly, Goldman Sachs predicts that oil demand will continue to increase until 2034 before eventually plateauing. This divergence in expert opinion adds another layer of volatility to the market, as different participants place their bets on varying future scenarios.

What This Means for Major Oil Companies and Financial Markets

The price of oil holds significant sway over financial markets, extending beyond mere supply and demand fundamentals. Major oil companies, often referred to as 'supermajors' – including giants like Exxon Mobil, Shell, Chevron, TotalEnergies, and BP – are deeply affected by oil price fluctuations, and their strategies can, in turn, influence broader market sentiment.

In recent years, these oil supermajors have engaged in massive share buyback programmes and generous dividend payouts. Last year alone, they collectively spent nearly $114 billion on dividends and share buybacks, a 10% increase on 2022 figures. This trend is expected to continue, with substantial buyback guidance for the third quarter of 2024. For instance, Exxon Mobil is projected to repurchase $5 billion of shares, Shell $3.5 billion, BP $1.75 billion, Chevron $4.2 billion, and TotalEnergies $2 billion. On an annualised basis, this could equate to a staggering $66 billion per year.

The primary motivation behind these aggressive buyback programmes is to boost flagging valuations. Many oil majors trade at significantly lower price-to-earnings (PE) ratios compared to the broader market indices. For example, BP has a 12-month forward PE ratio of 6.74x earnings, substantially lower than the FTSE 100's 11.62x. Similarly, Exxon Mobil's 12-month forward PE ratio of 13x earnings pales in comparison to the S&P 500's overall 20x. By reducing the number of outstanding shares, companies aim to increase earnings per share, making their stock appear more attractive to investors.

The crucial question now is whether the ongoing volatility in oil prices and the anticipated slowdown in future oil demand growth will weigh heavily on these share buyback programmes. If sustained lower oil prices impact profitability, the ability of these companies to continue such extensive shareholder returns could be challenged, potentially affecting their stock performance and, by extension, broader market indices where they hold significant weight.

All Is Not Lost for the Oil Majors

Despite the recent dip and the long-term concerns, it’s important to view the current oil price situation within a broader historical context. While Brent crude has fallen, its average price for 2024 so far remains above $82 per barrel. This compares favourably with an average price of $74 per barrel over the last five years. So, when viewed from a wider lens, the oil price for 2024 still appears relatively stable, even if it has experienced periods of sharp fluctuation. The market is currently operating within a discernible range, and while near the lower end, it hasn't completely broken down.

The resilience of the oil industry, its adaptability, and the ongoing, albeit debated, necessity of fossil fuels in the global energy mix suggest that while challenges lie ahead, the 'death of oil' is far from imminent. The industry continues to evolve, balancing the demands of energy security with the imperatives of sustainability, making it a sector worthy of continued observation.

Frequently Asked Questions (FAQs)

What is OPEC?

OPEC stands for the Organisation of the Petroleum Exporting Countries. It is an intergovernmental organisation comprising numerous oil-exporting nations. Its primary objective is to coordinate and unify the petroleum policies of its member countries and to ensure the stabilisation of oil markets in order to secure an efficient, economic, and regular supply of petroleum to consumers, a steady income to producers, and a fair return on capital for those investing in the petroleum industry. By collectively controlling a substantial portion of the world's oil supply, OPEC can influence global oil prices through decisions on production cuts or increases.

What is the OECD?

The OECD, or Organisation for Economic Co-operation and Development, is an intergovernmental economic organisation with 38 member countries, primarily high-income economies. It was founded in 1961 to stimulate economic progress and world trade. The OECD serves as a forum for governments to work together, share experiences, and seek solutions to common problems. Its reports and economic outlooks are closely watched for insights into global economic trends, including their potential impact on commodity markets like oil.

How does China's economy affect global oil prices?

China has been the largest single contributor to global oil demand growth over the past two decades. Its rapid industrialisation, urbanisation, and burgeoning middle class led to a huge increase in energy consumption. Therefore, any significant slowdown in China's economic activity, such as a decrease in manufacturing output, construction, or consumer spending, directly translates into reduced demand for oil. Given its dominant share of global demand growth, a slowdown in China can have a disproportionately large impact on overall oil market sentiment and prices.

Will the fall in oil prices lead to cheaper petrol at the pumps?

Generally, a sustained fall in crude oil prices does eventually translate into lower prices for refined products like petrol and diesel at the pumps. However, this pass-through isn't always immediate or one-to-one. Various other factors influence pump prices, including refining costs, distribution expenses, retailer profit margins, and, significantly, government taxes and duties. Exchange rates can also play a role, as crude oil is typically priced in US dollars. So, while lower crude prices provide a downward pressure, local market dynamics and taxation policies determine the final price consumers pay.

Is the world running out of oil?

The concept of "peak oil supply" – the point at which the maximum rate of petroleum extraction is reached, after which production is expected to decline – has been debated for decades. While finite, new exploration technologies, improved extraction methods (like fracking), and the discovery of new reserves mean that the world is not imminently "running out" of oil in the sense of physically depleting all reserves. The more pressing concern now, as highlighted by organisations like the IEA, is "peak oil demand" – the point at which global demand for oil begins to decline due to factors like energy transition, efficiency gains, and the rise of electric vehicles. This shift in focus suggests that future challenges for the oil industry will be more about finding markets for its product rather than struggling to find enough of it.

The global oil market is a complex ecosystem, constantly influenced by geopolitical events, economic shifts, and technological advancements. The recent decline in prices is a clear indicator of a market grappling with softer demand and an expanding supply. While the short-term outlook suggests continued pressure, the long-term future of oil is subject to a fascinating and ongoing debate between those who foresee a rapid transition away from fossil fuels and those who believe oil will remain a cornerstone of the global energy mix for decades to come. For consumers and investors alike, staying informed about these intricate dynamics is key to navigating the ever-evolving energy landscape.

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